Stocks are an important but challenging portion of your portfolio. With thousands of companies to choose from, how do you sort out the winners from the losers?
There are essentially two main categories of stocks: those that pay dividends and those that have a high share price growth potential. Dividends provide you with a steady but usually slow way of earning money from your initial investment. Growth stocks usually don’t pay a dividend but have the potential to have an exponential increase in share price, earning a greater return on your investment in exchange for a higher risk factor.
“Growth stocks are typically more technology driven or smaller start-up companies,” says Patrick Hanratty, managing director of Capital Advisors Ltd. “A dividend-paying company has products that are more defined.”
There are pros and cons to being in each class of stock.
“On the growth side, one of the pros is the stock has high potential for appreciation,” says Hanratty. If you pick a winner, your return can be very high.
“One of the cons of the growth side is there are thousands of companies to choose from. There are so many growth and mid-cap companies it is hard to pick a winner. There is also usually substantial risk. At all points in time, there needs to be a relationship between risk and reward. A stock might have the potential for being a homerun, but you also have the potential of losing all your money.”
Any offer that pitches the potential gains but denies any potential loss is most likely a scam. Big rewards always have big risks.
“Growth stocks can be the most risky piece of your portfolio,” says Hanratty. “You have the greatest number of options, and you’ve got a good chance of losing a lot of money. There’s not much chance of making it with a growth stock, but if you do, you’ll make it big.
“Everyone wants to own the next Microsoft. It’s all about homerun companies, but those aren’t core pieces of your portfolio. Those are the fringes.”
Dividend stocks are pretty straightforward. Most of them have long-established track records with strong brand names, and they are much less volatile than growth stocks. The dividends help hedge against a market downturn, but because the companies are established, much of the growth has already been achieved.
“Dividend-paying companies can’t have gotten to that point unless they’ve been around, made money, paid down their debt and aren’t so R&D driven,” says Hanratty. “Dividend companies are the staples of America. The con is they have a more limited upside.”
So what you invest in depends on your risk tolerance and cash flow needs.
“You end up with an average of anywhere from 25 percent to 75 percent of your portfolio in equities,” says Hanratty. “If you are only at 25 percent, then liquidity and capital preservation is important or you have no risk tolerance. If you are at 25 percent, then 90 percent of your equities should be dividend-paying or producing income. You probably don’t have the tolerance or time to do anything else.
“If you take it to the other side, with 75 percent in equities, you probably have a longer time horizon. You can go through several market cycles before you’ll have the need for money. You can be more growth-driven. I like diversification, so maybe you would have 50 percent in growth stocks and 50 percent in dividends of the overall 75 percent in stocks.” How to reach: Capital Advisors Ltd., (216) 621-0733
